Yen’s status as a haven currency will endure, despite declines

The yen’s status as a safe-haven currency has little to do with its value relative to other currencies.

By

JosephAdinolfi

Markets reporter

Many market strategists expect the yen to weaken against the dollar in the near term following Friday’s announcement from the Bank of Japan. But any sustained weakness won’t diminish the Japanese currency’s role as a haven.

The yen has surrendered nearly all of its gains against the dollar from the past six weeks since the BOJ revealed on Friday that it would soon begin charging an interest rate of minus 0.1% on new excess reserves held at the central bank.

Investors were blindsided by the decision, which came just days after BOJ Governor Haruhiko Kuroda advised the international investing community that the central bank had no plans to adopt negative interest rates during the World Economic Forum in Davos, Switzerland.

The currency posted its largest daily decline versus the dollar since Oct. 31, 2014 after the announcement—the day the BOJ shocked markets by unveiling a significant expansion of its regimen of asset purchases.

The divergence trade returns

The BOJ’s decision revived what market strategists call the monetary-policy divergence trade—the idea that the dollar will outperform most of its rivals as the Federal Reserve becomes the first major central bank to normalize monetary policy in the wake of the financial crisis.

Since mid-December, the dollar-yen currency pair has been closely correlated to oil, with the dollar weakening against the yen as oil prices slid. That wasn’t the case Monday.

However, it is important to note that the BOJ’s decision likely won’t have much of an impact on actual policy in the short term. Currency strategists at Brown Brothers Harriman calculated that the new negative rate will only apply to between ¥10 trillion ($82.4 billion) and ¥30 trillion of the more than ¥250 trillion in reserves held by the BOJ.

But the yen’s decline is more closely tied to the expectation that more cuts will soon follow as the BOJ struggles to hit its inflation target of 2%

“Instituting a small, 10-basis-point negative rate on newly created reserve additions is only the beginning of a policy change,” said David Kotok, chairman and chief investment officer at Cumberland Advisors.

What it means to be a so-called ‘safe haven’

But though the decision will lead to more weakness in the yen, it likely won’t tarnish the yen’s long-standing reputation as a haven currency, according to Eric Theoret, a currency strategist with Scotiabank.

Decades of current-account surpluses have positioned Japan as a net creditor to the world—a distinction it shares with another popular haven currency, the Swiss franc. An economy runs a current-account surplus when the value of goods and services that it exports is greater than the value of goods and services imported.

If you take the value of foreign assets held by Japanese investors, and subtract the value of Japanese assets owned by foreign investors, the sum places Japan among the world’s largest owners of foreign assets.

At the end of 2014, Japan’s net foreign assets—the sum of all foreign assets held by Japan, minus the value of all domestic assets owned by foreigners—stood at nearly ¥114 trillion ($942 billion), according to the latest data available from the World Bank.

This supports the yen during periods of risk aversion as Japanese investors repatriate capital, said Adam Cole, head G-10 currency strategist at RBC Capital Markets.

“When markets go risk averse, money tends to go home,” Cole said.

This will likely help support the currency during times of widespread market stress, but as investors process the risks posed by low oil and slowing growth in the developing world, and the Federal Reserve prepares for its second interest rate hike, many investors believe the dollar rally is back on—at least for now.

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